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The Fall of Bill Barrett Corporation (BBG)

Summary

Small companies with a lot of debt and very low margins cannot play OPEC games.

Insider sales give shareholders no confidence at all.

New share issuances will dilute non-existent earnings.

My lessons from buying BBG.

I cannot be thankful to BBG for its yield (the company has had negative EPS for three quarters in a row) or its capital gains (its share price has been falling for as long as I have known the company), but I can be thankful for the lesson I learned from adding it to my mock portfolio. That lesson is the sound advice our staff at Stock Rover preface our webinars and articles with: “before investing in any of these stocks be sure to do your own thorough independent research!”

Long before I had the gumption to invest my own hard-earned cash from my job in dining services on campus, I tried out a mock portfolio. I was very careful about losing my initial virtual endowment and was determined to treat it like my hard-won cash. I took a very conservative approach and invested a good part of my virtual cash in Coca-Cola (KO) and Unilever (UN). I then did due diligence on several companies, narrowing down my list and eventually deciding to invest in Apple (AAPL), Raytheon (RTN), and McDonald’s(MCD). I created several spreadsheets, and tried to really understand what these companies did, and how they did it. I had no idea what a Discounted Cash-flow Model was back then but I knew a number of financial ratios. I discovered many more and incorporated them into my research. I had also just taken a class in financial accounting and was determined to apply the newly acquired knowledge. Here is what the portfolio, recreated using Stock Rover, looked like:

Several months after I created my five-stock mock portfolio, I was still researching new companies and monitoring the performance of those I had already invested in. It was performing well but not beating all of the major benchmarks. I was still researching new companies and monitoring the performance of those I had already invested in, and also searching for good bargains I could add. I had narrowed my searches but still not found a company that I felt comfortable investing in. One new company I came across was Bill Barrett Corporation (BBG). BBG is a Delaware oil and gas company that explores, develops, and produces crude oil, natural gas, and natural gas liquids (NGLs). I liked the industry BBG belonged to (oil was yet to nose dive) but had not done enough research to fully comprehend the company’s financial condition. Unfortunately, the process of researching and analyzing companies, and then concluding that they were not good investments, had taken its toll on me. Without much research, I decided to buy BBG. At first BBG traded around the price at which I had purchased it; which lulled me into thinking that perhaps I had made the right decision. However, BBG did not stay at the $28 price; it started a long and painful decline. The following price chart shows how far BBG has fallen:

BBG has dropped from $28 when I bought it to $4.44 as of October 27th, 2015. That is an impressive 84.1% loss! On tough market days, such as Sept 25th, 2015, BBG has fallen to as low as $2.92 and this downward trend has had a devastating effect on my mock portfolio. Without BBG, my mock portfolio’s performance would have been quite impressive. Its 5-year Return would have been 107% while its 3-year performance would come in at 56.1%.

With the addition of BBG, the 5-year performance drops to 50.8% while the 3-year return is only 34.1%.

Compared to the industry, BBG has underperformed Oil and Gas for the past three years, even though oil did not start falling until end of June, 2014. While the oil and gas industry as a whole has experienced declining profits, BBG’s peers (Earthstone Energy, Isramco and Evolution Petroleum) have managed to beat the industry average.

Although the current oil glut has played a major role in the fall of BBG stock, it is not entirely the cause of BBG’s problems. BBG has played a substantial role in the fall of its stock price, and current BBG strategies do not project confidence in the company. For instance, insider transactions over the past six months reveal management’s lack of confidence in the company’s future. According to Stock Rover Markets, insiders sold 4.1% of shares they held in the last six months:

The BBG insider sales would not have been much of a problem if the share price was rising, but BBG’s stock price has been falling rapidly. Although no sales have been recorded in the past month (9/26/15 to 10/28/15), the total number of insider shares held has fallen from 684.27K to 518.52K — a 24.2% decrease.

Furthermore, management has plans to issue new shares as a contingent source of liquidity for financing capital expenditures. Even though they have not sold any shares under their Equity Distribution Agreement with Goldman Sachs, any new shares will dilute shareholders’ non-existent earnings (BBG has recorded losses for the past three quarters). Given that the company has not paid dividends in the past, BBG shareholders have no yield to show for their equity.

Additionally, BBG’s highly leveraged financial position exacerbates the company’s negative outlook. The interest expense has been rising over the years as a result of maturing long term debt. The majority of the debt matures in 2019 and 2022 but given that Saudi Arabia is playing for market share in lieu of price, and may be doing this for the foreseeable future, this mountain of debt presents a challenge for the company. Rising interest payments coupled with negative earnings leave little to no earnings for shareholders. Furthermore, even if BBG did make a profit, the 7.625% Senior Notes due 2019 and 7.0% Senior Notes due 2022 generally prohibit the company from paying dividends.

Lastly, even though BBG’s overall production fell by 37% (driven mostly by reduced Natural Gas Production), oil production rose by 15%. BBG has chosen to focus on increasing oil production to sustain its growth because their $320M to $350M capex budget, as reported in the 2015 Q2 10Q, is targeted exclusively on oil activities. The question becomes, will this strategy work? BBG is facing a cow-horns dilemma. On one hand, while this strategy makes sense because they have more hedges for their oil income stream than the natural gas stream, it is a strategy forced on by Saudi Arabia. Given falling oil prices, the other way for BBG to increase or even maintain revenue would be to increase production. This is Saudi Arabia’s strategy, choosing to maintain or increase market share instead of pushing for higher prices. Keeping this in mind, can BBG keep up? I think not, but even if they could, how long could they sustain this? Saudi Arabia may be playing this strategy for a number of years and they can afford to. But can BBG with its highly leveraged balance sheet and low margins play this OPEC game? I answer no, because even their current low margins have been sustained by commodity hedges which will fetch a weighted average price for oil of $89.81 in 2015. That price falls to $80.47 in 2016 but the effect is countered by a 24.7% increase in derivative volumes (the amounts of oil, gas, or NGLs hedged against price volatility). However, in 2017 both price and derivative volumes fall significantly; price falls to $75.61 and derivative volumes decline by 72.4%. The only way for BBG to increase its profit margins is to turn on the spigot. If they do not, their bottom line will suffer much more significantly.

Given all these signs that the company is in trouble, BBG’s fortunes may change because oil prices might have hit rock bottom and may be on the rebound. For example, since late August, crude oil rebounded from its sub $40 price to $45.74 as shown by Stock Rover’s commodities tab.

However, an oil rebound in the near term seems unlikely, at least as long as Saudi Arabia is not in significant budget deficit pains, because the larger part of their revenue for the national budget comes from oil. This is evidenced by recent measures from Saudi Arabia that signal its commitment to preserving market share such as withdrawing billions of dollars from global asset managers. Saudi Arabia plans to invest some of the $50B to $70B it withdrew in less risky and more liquid assets, which could be a sign that Saudi Arabia is preparing for a long low-oil-price market. Although Saudi Arabia has been challenged by other OPEC members, particularly Venezuela to reduce production, Venezuela does not have a coalition strong enough to take on Saudi Arabia and its supporters.

Another key player that is likely to contribute to keeping oil prices low is Iran, which has the fourth largest proven reserves according to the EIA. The nuclear deal is almost set for implementation because it has passed the Iranian parliament, the 12-member Guardian Council, and has received a cautious endorsement from Ayatollah Khamenei. President Rouhani has estimated that it will take about two months for Iran to comply with measures under the nuclear agreement that would see economic and financial sanctions lifted. Should sanctions be lifted, Iran is likely to ramp up oil production to win back lost market share.

Takeaways:

There are a few lessons I learned from adding Bill Barrett to my mock portfolio:

There is no substitute for your own due diligence. No matter how long you have been investing, you cannot escape the need for in depth research. Before parting with your money, it is prudent to make sure you understand the stock you are investing in.

I was not immune to bad calls. I think this was the most painful lesson to take. Sometimes even when all of an investor’s assumptions are correct, the market does not always turn out as expected. Most investors expected that increasing oil supply from the US would be countered by declining supply elsewhere so that producers could maintain high prices. So much for those expectations.

Unlike everywhere else in our lives where self-doubt might be bad, some self-doubt when it comes to investing is healthy. An investor has to question their own biases and assumptions. Overconfidence is the road to the poor house.

Conclusion:

My mock portfolio would have performed a lot better if I had initially done my due diligence on Bill Barrett. Thankfully, my investment in BBG was with a virtual endowment and not my real cash. I learned from this experience and have been much more diligent in researching stocks for my actual portfolio. This is the value of equity research platforms like Stock Rover; they give investors the ability to create multiple portfolios – some real and others virtual. More importantly, they enable investors to do what they would otherwise be unable or unwilling to do with their hard-won money. The lessons learned from those experiences can be translated and applied to real life portfolios.